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A Sympathetic Approach

19 January 2005 / Martin Riley
Issue: 3991 / Categories: Comment & Analysis , Arctic Systems , Jones v. Garnett , Income Tax
MARTIN RILEY takes an alternative view of the disputed interpretation of TA 1988, s 660A.

A FEW WEEKS ago, I was beginning to think that I was the only person in the country who thought that Jones v Garnett SpC 432 should be decided in favour of the Revenue. Then, at a recent Chartered Institute of Taxation branch meeting, some other branch members confessed to me that they felt the same — what a relief!


Like most advisers, it is unusual for me to side with the Revenue, but why should we be adversarial? At times I think we need to hold back and look at ourselves and ask whether we are being reasonable. I have referred in a previous article to the breakdown of trust between the professions and the Revenue (see 'Another Revenue-Induced Headache', Taxation, 8 July 2004, page 375) and I feel that both sides could be a little more reasonable on the subject of TA 1988, s 660A. It should not be a war of attrition.


In my opinion, where a husband/wife company has no capital base and there is a single employee then what we really have is a means by which one income can be carved up between two people. If that is not a settlement, then I am not sure what is. Clearly, however, where there is a good capital base then the transfer of shares from husband to wife should not be caught by s 660A as it would be an outright gift and not wholly or substantially a right to income.


This article will look at certain aspects of the Special Commissioners' decision and suggest ways by which both the Revenue and the professions might have been more reasonable. It is assumed that readers are familiar with the facts of the case. (See 'Poles Apart', Taxation, 7 October 2004, page 10.)




What was the settled property?


TA 1988, s 660G defines a settlement as including 'any disposition, trust, covenant, arrangement or transfer of assets' and there must be an element of bounty — seemingly at the time that the property is transferred. In Jones v Garnett, Dr Brice considered that the property given away under the terms of the settlement was the one share that was acquired by Mrs Jones when they subscribed for the shares. If this is a correct analysis then it could be argued that there was no settlement because the share was only worth £1 at that time which is the amount she paid for it. In other words there was no bounty at the time the assets were transferred into the settlement.


An important case mentioned in the judgment was IRC v Plummer [1979] STC 793, a House of Lords decision in which Lord Wilberforce, in his description of the settlement provisions, stated:







'They are designed to bring within the net of taxation dispositions of various kinds … in which a taxpayer gives away a portion of his income, or of his assets, to such persons, or for such periods …'






This leads me to think that what is really being given away in this situation is Mr Jones's income earning capacity. At the end of the day, surely this is the asset that is being given away? The acquisition by Mrs Jones of one share, the payment to Mr Jones of a low salary and the subsequent payment of a dividend are all part of the arrangement, which in this case constitutes the settlement — but they are just the steps required to legally carve up Mr Jones's income. (I use the word 'legally' here to emphasise that they have done nothing illegal — it is simply that for tax purposes the income will be taxed on Mr Jones if the settlement provisions apply.)


You may be thinking that one's ability to earn income in the future is not an asset which can be divided or given away, but I believe it is — as Ray Parlour, the footballer, has found to his cost when his wife was recently awarded one third of his earnings for a four-year period in a divorce settlement. I would suggest that Mr Jones effectively transferred half of his income earning capacity to his wife for an unspecified period of time. The fact that he was a sole director and could control the salary that he paid to himself (and thereby control the amount of income that might be paid to Mrs Jones) merely suggests to me that it is a revocable settlement. He had no service contract and could at any time cease to work for Arctic Systems Limited and take up alternative employment (or even self employment).


If the asset transferred is Mr Jones' income earning capacity, then there is bounty at the time the asset is transferred — given that he will pay himself an uncommercial salary and then declare a dividend and that these are part of the arrangement. Some commentators have suggested that the asset transferred is the single share and that this should be viewed in isolation. Indeed, this was the view adopted by Dr Brice, but I am suggesting that the High Court might decide that the complete arrangement has to be viewed as a whole and that it is effectively a transfer of Mr Jones' income earning capacity.




The fit with previous case law


I cannot see that this analysis contradicts any previous case law. It is, of course, a wider interpretation, but I cannot see any clear contradiction. One of the problems with this case is that the facts of any previous cases heard before the courts were very different — the only recent case was Young v Pearce [1996] STC 743, where the facts were quite extreme and of no particular help at all.




Will the legislation be disapplied?


Once an arrangement is within the ambit of s 660A(1), then the next question is whether or not it can be excluded by virtue of TA 1988, s 660A(6) which states:







'The reference in subsection (1) above to a settlement does not include an outright gift from one spouse to the other of property from which income arises unless:


a) the gift does not carry the right to the whole of that income; or

b) the property given is wholly or substantially a right to income.


'For this purpose a gift is not an outright gift if it is subject to conditions, or if the property given or any derived property is or will or may become in any circumstances whatsoever, payable to or applicable for the benefit of the donor.'






I would hope that this will prevent any husband/wife companies being caught where there is a substantial capital base so that any outright gift of ordinary shares in such situations will not therefore be caught. It is thus disappointing that the Revenue found it necessary in paragraph 3.8.4. of its recently published guidance (on the Internet at to state that the settlement provisions might apply in such circumstances. In very extreme cases this might be the case, but it would be very hard to imagine such a case so that its comments only serve to provide confusion.




Was this a commercial arrangement?


Reading through Miss Powell's judgment in Jones v Garnett (in favour of the taxpayer), I cannot help thinking that she took too generous a view. She points out quite correctly that the first step was to set up the company because this was necessary to enable the business to be established. This was presumably because clients would not be willing to take on Mr Jones as a sole trader and risk any PAYE and National Insurance liabilities if he was later found to be an employee. Clearly this was a very commercial reason for setting up the company. She then goes on to say:







'… having identified the need for a company, he wished to divide the company's shares between them equally because of the professional advice they had received about the potential advantages if they each received dividend income which they could only do if they both owned shares in the company. It was clear that the appellant regarded the potential tax advantages of sharing the shares as an incidental benefit of the corporate vehicle which was required to achieve the main purpose of securing the contracts.'






Surely this has to be incorrect. Yes, the corporate vehicle was to secure the contracts, but the only benefit I can see of splitting the shares is the tax benefit. If, as she claims, this was just an incidental benefit, then what was the main benefit?


Miss Powell also says that she was impressed with Mrs Jones's 'air of calm competence' and that she could see that her support and willingness to undertake this administrative role was an important factor in the couple's decision to set up a consultancy business. However, the facts of the case state that, in a period of four-and-a-half years, Mr Jones' company provided computer consultancy services to three agencies and through them to four clients. Mr Jones was not a person who had, say, five appointments a day and needed someone to take phone calls and maintain his diary. It appears that Mr Jones was engaged on long-term contracts and, whilst Mrs Jones arranged appointments for interviews for contract renewals, this would not be very onerous when there were only four contract renewals in four-and-a-half years!


So my conclusion is that this was not a commercial arrangement — Mrs Jones did a few hours a week (at the most) of administrative support for which she received a small salary and half of the profits of the company. If she had undertaken a sales-type role arranging appointments for a team of three to four employees, I would look upon the arrangement quite differently because it could then be argued that she was as valuable to the business in a sales role, winning new contracts, as the people who actually did the work. In my opinion that would be a bona fide joint venture between husband and wife where each had a valuable input and the company profits could be attributable to both husband and wife.




Intention of Parliament


Mr Gammie argued on behalf of the appellant that the literal words of s 660A(1) would not have been in accordance with the intention of Parliament when the independent taxation of married women was introduced in 1989. I cannot agree with this.


It is accepted that income-producing assets such as rental properties and quoted shares can be held jointly between husband and wife and TA 1988, s 282A(1) splits the income equally for tax purposes. But since 1989, hundreds of thousands of 'micro businesses' have been set up — some employing a small number of people and many employing just one person or, like Arctic Systems Limited, one person plus a part-time secretary. These businesses would previously have been sole traders, but most have now incorporated perfectly legitimately largely due to the tax benefits of trading as a limited company. I believe that if Parliament had known that some companies would then go one step further and arrange for one income to effectively be carved up between two people, it would have intended such arrangements to be within s 660A.




What about prior years?


I do think it is outrageous that the Revenue was attempting to collect tax for previous years from Mr Jones (and only backed down on a technicality). The facts of the case suggest to me that Mr Jones is a perfectly responsible businessman who is doing his best to comply with the law. He is earning a good, honest living — he is not one of the show business personalities earning hundreds of thousands of pounds who, according to press reports, are also being 'attacked' by the Revenue. In 2000-01 and 2001-02 he even received a much higher salary because he felt that the IR35 provisions applied to him. Why should the Revenue try to extract the maximum amount of tax out of him?


The Revenue should acknowledge that this is not aggressive tax planning where advisers are trying to push the rules to the limit. Advisers did not seriously anticipate that this interpretation would be applied to s 660A until the Tax Bulletin of April 2003. It is not a case of having simply overlooked or ignored s 660A — for which discovery assessments would be wholly appropriate. It is simply a matter of different interpretation which even two highly respected independent Special Commissioners cannot agree on. Therefore the time is now right (after the Special Commissioners' split decision) for the Revenue to publicly state that it will not seek to adopt this approach for years prior to 2002-03, whatever the outcome of the case in the higher courts.




Why investigate only 100 cases?


According to Mark Lee on AccountingWeb, the Revenue will only investigate about 100 cases a year. I think this will cause further problems to some advisers if they believe that the settlements legislation would apply and the client then takes his business to a competitor who is prepared to ignore this legislation. I have heard similar stories with the IR35 legislation where local firms have lost business.


If the Revenue is serious about IR35 and s 660A, then it should carry out more enquiries in an attempt to catch those who are blatantly ignoring the rules.




Where is professional judgment?


On the part of the professions, I do think that we sometimes expect too much in the form of guidance from the Revenue. That is not to say that I think the recently published guidance is sufficient — I am hoping (perhaps in vain) that we shall have some clearer information in due course. However, there is a very large grey area surrounding s 660A and we have to accept that tax is not always black and white and that sometimes it is a question of professional judgment and ultimately risk management. Surely professional judgment is part of what we are being paid for?


The same is true of IR35. A client of mine paid over £27,000 in tax and NICs in April 2004 because, although he was very much a borderline case, I did not feel confident that we could defend his position strongly if it was challenged. It was so borderline that I consulted a firm of IR35 specialists — who confirmed my view (that it was very borderline). It was therefore the client's choice whether or not to take the risk, and he chose not to. Sadly, however, he works alongside other contractors who, as far as we are aware, are working under an identical contract and drawing dividends. This is why I would like to see more Inland Revenue activity in this area to create a level playing field. The same will be true of s 660A.




Where do we go from here?


The Revenue must be clear that this is a hugely important issue for accountants, tax advisers and lawyers throughout the country — much greater than it perhaps realised

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